Fixed indexed annuities (FIAs) have surged in popularity because of their potential for growth when markets are strong and ability to ensure principal protection in down markets. Because the floor on FIAs is zero, clients never take a loss due to a market downturn. And because interest credits are based in part on the performance of market indices, most commonly the S&P 500®, FIAs may increase in value when the indices they include perform well.
But FIAs aren’t limited to benchmark indices like the S&P 500®. Increasingly, financial professionals are discovering the benefits of custom indices, which can be linked to a range of investment classes. Custom indices can further safeguard clients against the impact of down markets and are intended to help them thrive in different economic climates.
Diversifying in search of improved results and reduced risk
Financial professionals frequently talk with clients about the importance of holding a diverse portfolio. Mutual funds and some index funds are built around this fundamental idea. In FIAs, using custom indices along with the S&P 500® may help risk-adjusted growth potential in certain market conditions by weighting stocks differently than the S&P 500® does, or by including a broader range of assets. Custom indices can reflect investment classes such as international equities, bonds, commodities, technology stocks and other vehicles.
“We suggest people consider a basket of alternative indices,” says Adam Politzer, senior vice president and chief product officer for Athene, the leading provider of fixed indexed annuities to financial institutions and independent insurance producers.* “If you diversify your money and put half in U.S. equities and half in a multi-asset index, you're more likely to get a credit in each and every period.”
Custom indices that historically have performed differently from one another in different kinds of markets can be combined to provide a greater chance for appreciation across economic cycles, inflationary environments and market trends. “We’re trying to curate an index lineup where each index is going to perform in a slightly different environment,” Politzer says.
Mitigating volatility to look for value
Custom indices, which have been used in FIAs for more than 20 years, are built around real-world market dynamics. Unlike actively managed funds, custom indices are rules-based; they monitor the market and execute preset criteria with the help of technology. The latest algorithms employed by some asset managers conduct intraday analysis and provide immediate response to changing market conditions, increasing or reducing investment risk based on market volatility. The use of algorithms is intended to boost efficiency and cost-effectiveness for the insurance company, while providing transparency into the progress of the index toward its stated objectives.
Sophisticated asset allocation features have become part of custom indices—features previously available only to pension plans and other institutional investors. These features have the potential to improve performance compared to an index using simple static asset allocations, such as 60% equities and 40% bonds.
Custom indices can also incorporate a risk-control feature that seeks to manage volatility to a specific target, such as 8%. This feature can dramatically reduce volatility. It is intended to allow custom indices to toggle between more market exposure during periods of market stability and a cash-like component in more volatile environments. The range of both the positive and negative performance of the index is limited. Research conducted for Athene by The Index Standard, which provides objective ratings for indices and index-linked products, showed that between July 1, 2019, and June 30, 2022, the average maximum decline of all U.S. volatility-controlled custom indices was 11.5%, compared to a maximum decline of 33.9% for the S&P 500®.
The risk control feature provides another benefit: All index funds use options to protect against losses, and options for less volatile investments are much less expensive. Option budgets do not provide insurance companies with profits and are used solely to provide value, so less expensive options benefit the client. “By controlling the volatility of all these indices, the options are cheaper, allowing us to buy more upside on behalf of clients,” Politzer says.
The interest credit that clients may receive is typically determined by a participation rate. The participation rate is a factor applied to any positive index return to determine the interest credit for that period. Custom indices may offer participation rates of more than 100% because of their volatility control mechanisms, while those tied to the S&P 500® generally have much lower participation rates because of their greater degree of instability. Option costs on volatility-controlled indices also trade within a very narrow range and are more predictable from year to year, ensuring clients do not face large rate swings from one year to another. Plus, renewal rate consistency helps financial professionals speak with confidence about participation rates across investment cycles, which in turn gives clients confidence about the advice they receive.
"We believe strongly in the value custom indices provide," Politzer says, "These options inside of an annuity are likely to offer improved risk-adjusted returns and more protection from market volatility when needed."
*Per LIMRA US Individual Annuities YTD 4Q2022, Athene ranked number one in fixed indexed annuity sales for calendar year 2022.
For financial professional use only. Not to be used with the offer or sale of annuities.
Guarantees provided by annuities are subject to the financial strength of the issuing insurance company.
Indexed annuities are not stock market investments and do not directly participate in any stock or equity investments. Market indices may not include dividends paid on the underlying stocks, and therefore may not reflect the total return of the underlying stocks; neither an index nor any market-indexed annuity is comparable to a direct investment in the equity markets.
Athene Annuity and Life Company (61689), headquartered in West Des Moines, Iowa, and issuing annuities in 49 states (excluding NY) and D.C., and Athene Annuity & Life Assurance Company of New York (68039), headquartered in Pearl River, New York, and issuing annuities in New York, are not undertaking to provide investment advice for any individual or in any individual situation, and therefore nothing in this should be read as investment advice.
INVESTMENT AND INSURANCE PRODUCTS ARE: • NOT INSURED BY THE FDIC OR ANY FEDERAL GOVERNMENT AGENCY • NOT A DEPOSIT OR OTHER OBLIGATION OF, OR GUARANTEED BY, THE BANK OR ANY BANK AFFILIATE • SUBJECT TO INVESTMENT RISKS, INCLUDING POSSIBLE LOSS OF THE PRINCIPAL AMOUNT INVESTED
Vanilla is extending its estate planning tech to Callan Family Office's ultra-high-net-worth business, while WealthFeed's organic growth engine will now be available to roughly 100 advisors at The Mather Group.
“We are helping families take an important first step toward building a financial foundation for the next generation,” said Franklin Templeton CEO Jenny Johnson
Richard Brothers Financial Advisors joins the fee-only RIA, adding its first Maine office and $240 million in client assets
Cleveland RIA grows to $68 billion in assets as Philadelphia team, deepening its high-net-worth and retirement-plan practice.
Financial planning leaders say unresolved rules on fees, Roth conversions and financial aid complicate comparisons with 529 plans.
Dan Biagini of American Equity says the steady decline of pensions, longer lifespans and a reset in interest rates are rewriting how advisors build retirement income
Direct indexing is on pace to outgrow ETFs and mutual funds. Northern Trust's Ken Lassner explains why the advisors who get it wish they had started sooner.
